The economic model that sustains quality TV is under assault. Does the future have room for any more Walter Whites?

Source: Salon.com

Viewers be warned! The golden age of television is coming to an end, and here’s how it’s going to happen: An unholy cabal of judges, government regulators and “cord-cutting” millennials will decapitate it. Like the similarly beheaded Ned Stark, on HBO’s “Game of Thrones,” we will miss it dearly when it’s gone.

For years, the “future of TV” has been an evergreen topic of discussion, but rarely have we seen weeks like the one just past, in which a cascade of news-breaking developments all but overwhelms our ability to make sense of them.

To recap: On Tuesday, Netflix lambasted the proposed Comcast-Time Warner merger, declaring it “a long-term threat” to the healthy ecosystem of the Internet. Comcast promptly riposted, dismissing Netflix as a querulous, hypocritical whiner with a shaky grasp on the facts. Then, on Wednesday, HBO sucker-punched Netflix by agreeing to stream HBO shows through Amazon Prime, and AT&T fired a warning shot across everyone’s bow by announcing its own plans to get into the streaming video business with a “Netflix-like” service. Also on Wednesday, the Supreme Court heard arguments in the case of American Broadcasting Companies, Inc. v. Aereo, Inc., which could end up resulting in the most influential high court ruling regarding how TV programs are distributed in decades.

And, to cap it all off, the FCC on Thursday released a tentative set of new guidelines for net neutrality that were immediately greeted by critics as an appalling sell-out of “net neutrality,” and the hallowed guiding principles of the “Open Internet.”

Whew!

To fully explore the intricacies of what’s at stake in any single one of these industry-reshaping eruptions would gobble up more hours than a marathon binge-watch of all five seasons of “Breaking Bad.” But there’s a crucial common thread: In every case, the economic model that currently underpins television (and bankrolls our amazing proliferation of high-quality productions) is under sustained assault. This is happening both from the bottom-up, as so-called cord-cutters seek an à la carte programming future; and from the top down, as telecom companies consolidate near-monopoly control of broadband. In the process, an inevitable transfer of power — from the content creators who make “Mad Men,” “Game of Thrones” and “Justified,” to the cable and satellite and telephone companies that distribute those TV shows — is underway.

It’s a complex witches’ brew: The changing habits of television consumers, the disrupting influence of technological innovation, and the decisions of both courts and regulators are enabling this shift. How everything will shake out is far from certain, but there’s a more-than-good chance that when we get to the other side, the landscape of television will be altered for the worse.

The reason why is simple: Great television requires an awful lot of money. If content creators end up with a smaller piece of a shrinking pie … well, you don’t have to be Don Draper to figure out which way the wind will blow.

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Before we can figure out how all the pieces in this crazy jigsaw puzzle fit together, we need to take a close look at how the TV business currently functions, and understand why so many people are unhappy with it. Because here’s the funny thing about the golden age of television: Even though there are more outstanding shows on the air than we can squeeze into our overstuffed DVRs, there’s also no shortage of grumbling. Specifically, there is widespread dissatisfaction with how hundreds of TV channels are packaged into all-or-nothing “bundles.” And people just don’t seem to like bundling.

It’s easy to see why. If you aren’t a sports fan, why should you be paying for ESPN or the NBA on TNT? If you don’t have kids, what’s the use of Nickelodeon and the Disney Channel? If all you crave is “The Americans” and “Fargo” and “Girls” and “Silicon Valley” why must you still be forced to flip through scores of channels stuffed with reality TV and “Big Bang Theory” reruns? This isn’t how we consume our music or our news in the Internet era. Why are we still stuck in this antediluvian age when it comes to TV?

Last Friday I ranted against the notion that the rising numbers of “cord-cutters”– people canceling their cable TV subscriptions (or never signing up in the first place) — posed any kind of meaningful threat to the profitability of Comcast and the handful of other cable TV giants. After all, even cord-cutters need to get their Internet bandwidth from someone, and most often, that someone involves a “cord” owned by their local cable company. Indeed, just this week, when Comcast announced its bang-up second quarter earnings, the company reported 383,000 new Internet subscribers. (Comcast also added 24,000 cable TV subscribers, undermining the “cord-cutter apocalypse” hypothesis.)

Readers challenged my thesis. Cord-cutting might not kill Comcast, they argued, but the practice of switching from cable to online consumption of TV did present a serious threat to bundling. The future, they declared, will be an “à la carte” utopia in which we only pay for exactly what we want. Just as iTunes ended the tyranny of albums over singles, the Internet will blow up the TV bundle. That’s just the way things work in our point, click and consume era.

The argument makes intuitive sense. Why spend $80 a month for Comcast, when some combination of Netflix and Hulu and YouTube and Amazon Prime and iTunes (and BitTorrent!) can get you almost as far as you’d like to go for a lot less than a cable subscription? But there’s a missing piece, and it’s the key to understanding everything that’s going on in the crazily evolving world of TV: Bundling is what pays the rent. An unbundled world weakens content creators, strengthens the ISPs, and puts net neutrality under huge pressure. So be careful what you wish for.

Without bundling, most channels that currently exist wouldn’t be economically feasible, and those channels that do survive would cost considerably more than they do now. Today, bundling funnels billions of dollars from the owners of the distribution infrastructure — the cable companies and satellite operators — to the networks and channels that create the shows that we want to watch. But all that will change if bundling goes away. In the worst-case scenario, the producers of content will actually be forced to pay the distributors to get their shows to the people.

The current system works like this: Popular channels charge a “subscriber fee” to the cable and satellite companies for the right to rebroadcast their shows. The fees can run as high as $5 per subscriber (as in the case of ESPN, the most valuable cable property). The fees are under constant negotiation, rising and falling according to the channel’s perceived popularity. In an environment where advertising revenue is under constant assault from technological innovation (your DVR) and Internet competition, those subscriber fees can add up to as much as half the total revenue for a channel.

In this system, the popular channels subsidize the unpopular ones, because the pay-TV distributors group everything together and charge a single fee to their own subscribers that more than makes up for the costs of acquiring programming. However, unbundling would undo that arrangement. If you subtract the subscriber fee revenue, even the most popular channels would be forced to raise their direct-to-consumer prices to cover their costs. For example, if sports fans were to buy ESPN directly, for ESPN to maintain its current profitability, it would have to charge its audience vastly more than it charges the cable companies. In an apocalyptic research note published by Needham Research last year, analyst Laura Martin predicted that unbundling would devastate the TV economy:

Unbundling dwarfs any other risk to the TV ecosystem, as we calculate that ~50% of total TV ecosystem revenue (about $70 billion) would evaporate and fewer than 20 channels would survive in an a la carte world where consumers are required to bear 100 percent of the cost of the channel.

Martin may or may not be exaggerating the total damage from unbundling, but the key insight to grasp here is that there is a significant flow of funds from cable companies like Comcast to ESPN and ABC and FX and TBS. Unbundling attacks that flow of funds. Yes, in many cases those channels may be raking in more revenue than they would be able to in a purely competitive market. But a purely competitive market would constrict the flow of cash necessary to produce great television. In a purely competitive market, low-traffic, high prestige channels like AMC would be struggling to survive, because many of us would be unwilling to pay the high premiums necessary to cover the costs of making something like “Mad Men.”

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With all that in mind, let’s return to the events of the past week and see how they plug into the picture.

Let’s start with the HBO-to-Amazon announcement, along with the news that AT&T is getting into the streaming business. Both business moves implicitly acknowledge the fundamental change in user behavior that’s going on. Audiences are moving online, and they’re picking and choosing what they want to see. They’re not actually cutting cords, but they are voting with their feet against the bundling status quo. We are headed to an extraordinarily competitive future — one in which a handful of players compete on both price and selection to get us to hit the buy button.

But the move to online means that whoever controls the bandwidth pipes has extraordinary power. That’s why, for example, Netflix is opposed to the Comcast-Time Warner merger. The merger would give Comcast a dominating position in the provision of broadband Internet access. That dominance, in principle, would grant Comcast the power to dictate terms to anyone who wanted to deliver content over the Internet, be that Netflix or Amazon or Apple or Google. Hey, guess what — Comcast happens to own a big stake in Hulu, which raises the obvious question: Does Hulu get a break on bandwidth charges? Is Hulu subject to data caps? Right now, no. But …

Of course, price discrimination à la the Hulu hypothetical is exactly what net neutrality is supposed to stop, but the new guidelines released by the FCC — now chaired by Tom Wheeler, a former lobbyist for the cable industry — strongly suggest that, going forward, the telecom companies will be allowed to charge content providers for access to their Internet pipes — except when “commercially unreasonable,” whatever that means.

I’m predicting a great deal of litigation, in the future, over exactly what constitutes “commercially unreasonable,” but for now, it is clear that the FCC has given Internet service providers such as Comcast a leg up over the content companies. To get “House of Cards” to you, Netflix is already paying Comcast a hefty fee. It seems crazy, but what happens when HBO has to pay Comcast to stream “Game of Thrones” via Amazon? Maybe ”Game of Thrones’” humongous production budget takes a hit?

Interestingly, the Supreme Court’s Aereo case may be the most relevant of all this week’s developments to the future of TV. The details and legal issues at play in that case are fascinating and complex. (For a comprehensive explanation you can’t do better than SCOTUS Blog. And, for a more digestible introduction to the issues, Salon’s own Sarah Gray has an excellent Q&A right here.) But the bottom line is that this is a fight about money. Aereo has figured out an (arguably) legal technological hack that allows it to distribute broadcast TV content over the Internet without paying the same fees that cable companies or satellite TV operators are forced to pay to distribute that same content to their subscribers. If Aereo can get away with this, the pay-TV operators are likely to argue that they too should be able to do so. And whooooosh – there goes another huge stream of income previously enjoyed by the broadcast TV channels.

And if Aereo doesn’t get away with it, that opens up another huge can of worms, potentially affecting the entire emerging industry of cloud computing. But that’s a separate issue. The truth is, whether Aereo succeeds or fails in court may be moot. So far, content companies have had about as much success resisting the disruptive influence of Internet technologies as English kings have had in resisting the tide. We’ve seen this narrative play out before, when Internet distribution models upended the traditional business models of the music and publishing industries. You can even argue, as does Needham’s Laura Martin, that the Internet resulted in the “unbundling” of both the album and the newspaper — and in the process, sucked a huge amount of revenue out of both industries.

The great mystery is how TV has managed, so far, to resist this disruption. The answer, now that we’ve digested all the things that have happened this week, is that it might just be a matter of time. Yes, we are paying too much for cable bills, and we will find more inexpensive options as time goes on. But that, in turn, may make the next “Game of Thrones” a lot chintzier than the current offering. Enjoy it while it lasts.